Banks line up for cash at Fed auction

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KAI RYSSDAL: I'm going to trot out a couple of phrases here that we usually have to deal with only on days the Federal Reserve makes an interest rate announcement. The Federal Funds Rate is what the Fed wants banks to charge each other for short-term loans. It's 4.25 percent right now. The Discount Rate is what the Fed itself charges those banks -- 4.75 percent at the moment.

You good so far? All right. Now, bearing that in mind, we told you last week the Fed wanted to try something new to unfreeze this country's credit markets. What they did was have an auction. A cash auction. They held it yesterday -- $20 billion was up for bid. Banks offering to pay the highest interest rate got the cash.

Today we learned how it went. Banks gobbled up the money. But they paid 4.65 percent interest for it. That is, more than they would have had to pay if they just asked the bank next door for a loan. Our New York Bureau Chief Jill Barshay takes it from there.

Jill Barshay: More than 90 bankers turned up at the Fed's auction party this week. Banks were so desperate for government money that they asked for three times more than what the Fed was prepared to lend.

Peter Cohan is a business professor at Babson College. He says the Fed's money was expensive. But the banks grabbed it because they're unwilling to lend to each other like they usually do.

Peter Cohan: Banks have lost confidence in each other. They've lost confidence in each other as credit risks.

Cohan says most banks are still sitting on mountains of losses from their investments in subprime mortgage securities. Many aren't fessing up to how badly they've been affected. So banks don't know who's a safe bet to lend to.

Cohan says the Fed hopes its money will boost banks' confidence. And then, maybe, banks will start lending to each other again.

Cohan: It's like setting a match and getting the motor started again. It's trying to prime the pump so it can sustain itself.

Not everyone is convinced that the banking system's engine is turning over yet. Vincent Reinhart at the American Enterprise Institute used to run monetary policy at the Fed. He says banks that can't lend to each other are also less likely to lend to their customers.

Vincent Reinhart: We're already seeing from opinion surveys of bankers that they're cutting back on their lending to businesses. If there's a more widespread and pronounced cut back in credit, then that could affect spending. And we're already having an economy that's growing pretty weakly.

Reinhart says the Fed is giving itself several goes to get the engine humming. The next auction is tomorrow. Another $20 billion will get pumped into the banking system.